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RBI FX swaps: No innocuous intervention technique

T. B. Kapali

IT is well-known that the Reserve Bank of India is a very active player in foreign exchange swaps. An analysis of the RBI's dollar purchase/sale statistics over a period of time clearly shows the RBI being quite heavily engaged in the FX swaps market.

More significantly, the RBI has always structured its swaps in such a way that it always runs outstanding dollar sale positions on its books -- i.e. the RBI almost continuously runs a forward liability to sell dollars to the market. This clearly show s that the first leg of the swap is buy dollars (spot) which injects rupee liquidity into the financial system.

The rationale is quite understandable -- the RBI, in recent times, has been utilising the foreign exchange market to better attain some of its money market objectives. Conducting swaps in the buy spot/sell forward sequence is done specifically t o create fresh rupee liquidity and maintain an environment of softness in the domestic money markets which subserves the central bank's other larger objectives -- say, with respect to public debt management. (Indeed, as a study of movem ents in overnight rates over the past few years indicates, the RBI has been able to sustain a good degree of softness in the money markets -- overnight call money averaged around 8/8.5 per cent in the three years up to 1999-00 despite te mporary bouts of volatility, which has seen call zooming to even 100 per cent levels.)

But, it is still a little difficult to understand why the RBI should be supplying rupee liquidity to the markets when the local currency is under pressure in the exchange markets. And, that is precisely what the RBI has been doing over the past few month s with the rupee plumbing fresh new lows against the dollar.

One can assume, very reasonably, that even the slightest level of unwarranted volatility in the dollar/rupee market -- as defined by the RBI -- would see the central bank tightening rupee credit/making liquidity scarce and that this monetary tig htening would also include the cessation of buy spot/sell forward swaps.

But, as recent developments seem to point out, the foregoing is only partly true. The RBI does tighten liquidity and adopts a dear money stance when the rupee is under pressure. But, with one important exception -- it continues to conduct buy spot dolla rs/sell forward swaps, injecting fresh rupee liquidity into the system even as already plentiful supplies of the local currency are pushing down its external value.

Obviously, there are some larger objectives (if not ulterior motives) behind the RBI's stance in the swaps market.

For one, it is quite possible the RBI tries to dampen bearish rupee expectations by conducting the FX swaps. Buy spot/sell forward swaps directly and immediately affect the forward premium on the dollar pushing it down. A lower premium on the forward dol lar, in turn, could possibly slow down dollar purchases if market participants also scale down their (bullish) dollar expectations. The accompanying chart on forward dollar premia in the 2-month period May-June, during which time the forward liabilities of the RBI have shot up (see table), indeed points to the possibility of such a strategy at work.

Another reason could be the sheer propaganda value which buy/sell swaps seem to create. Swaps in the buy/sell sequence provide an immediate boost to the reserves, even as the forward liabilities do not find a mention in the information meant for the gene ral public. Indeed, dollars bought in the spot market immediately go into the reserves (which is publicised every week by the RBI) but the sale leg -- involving the forward liability -- does not find a place in the weekly statistics. And, of course, eve n a billion dollar boost to reserves when the rupee is under pressure can provide a measure of psychological comfort to the general market.